Litigation Alert >> Commercial Lease Rent Acceleration Clauses: For How Long Will They Be Enforceable?

Litigation Alert >> Commercial Lease Rent Acceleration Clauses: For How Long Will They Be Enforceable?

May 11, 2015

A recent decision from the New York Court of Appeals calls into question the future enforceability of rent acceleration clauses in commercial leases – i.e., those that allow for the immediate recovery of the remaining rent due under the lease when a tenant defaults. The case, 172 Van Duzer Realty v. Globe Alumni Student Assistance, raises issues as to whether courts will continue to enforce these clauses as reasonable liquidated damage provisions or eventually deem many to be unenforceable penalties.

BackgroundCourts typically do not interfere with the freedom of parties to negotiate arm’s length agreements, and therefore are inclined to enforce a liquidated damage provision that results from a fair negotiation between sophisticated parties. Indeed, the party seeking to avoid an award of liquidated damages must show that the provision disproportionately benefits the plaintiff beyond the damages it otherwise would have received. Before the Court of Appeals decision in Van Duzer, it seemed likely that courts would continue to enforce rent acceleration provisions as a reasonable estimation of the likely damages to a landlord, especially since commercial landlords have no obligation to mitigate damages upon a tenant’s default. But this may not be the case after the logic applied by the Court of Appeals in the Van Duzer case.

Van Duzer CaseIn Van Duzer, the plaintiff-landlord entered into a commercial lease for premises that were used by the defendant-tenant as a dormitory for a non-profit educational institution. The lease provided that upon the tenant’s default, the landlord could terminate the lease, repossess the premises, and was “entitled to recover, as liquidated damages a sum of money equal to the ... balance of the rent for the remainder of the term.” The lease also stated that “[i]n the event of lease termination, tenant shall continue to be obligated to pay rent and additional rent for the entire term as though th[e] lease had not been terminated.” Several months into the lease, the landlord sent the tenant a notice to cure various defaults under the lease. The tenant ignored the notice. Instead, the tenant vacated the premises and stopped paying rent. The landlord terminated the lease and commenced an action to recover possession and past due rent. The Civil Court awarded the landlord possession, but not a money judgment.

After the Civil Court proceeding, the landlord sued the tenant in New York State Supreme Court and sought to enforce the liquidated damage provision that allowed for the landlord’s immediate recovery of the remaining rent due under the lease. The Supreme Court granted judgment to the landlord, finding the tenant in breach of the lease, and awarded the landlord a money judgment for the full amount of rent that would have come due under the lease.

The Court of Appeals affirmed, but sent the case back to the Supreme Court to determine whether an undiscounted accelerated rent clause (i.e., a clause that did not provide for a net present value discount) provided the landlord with a windfall to collect more than what it would have otherwise received “notwithstanding that the landowner had possession, and no obligation to mitigate.” The court gave credence to the argument that because the landlord obtained possession of the premises, the accelerated rent should have been discounted to present-day value. It held that “Defendant should have had the opportunity to present evidence that the undiscounted accelerated rent amount is disproportionate to [landlord’s] actual damages ...”

Court of Appeals DecisionWhat is most interesting about the Court of Appeals decision is its logic. The Court of Appeals considered a lease acceleration clause which gave the landlord both possession of the premises during the term of the lease and the right to immediately recover all rents due under the lease to be akin to “double-dipping.” Although the Court of Appeals focused on the fact that this acceleration clause did not account for net present value, it was not the absence of a net present value adjustment that created the “double-dipping.” Rather, if a landlord has no duty to mitigate its damages, then one could argue that most acceleration clauses (whether they account for net present value or not) similarly allow landlords to “double dip.”

Notably, based on the reasoning in this decision, it appears that Van Duzer is less likely to impact acceleration clauses that account not only for net present value, but also limit a landlord’s recovery to the difference, if any, between a lease’s scheduled rent and fair market value.

Bottom Line

The Court of Appeals’ holding in Van Duzer raises questions as to the future enforceability of rent acceleration clauses in commercial leases that do not account for net present value and that give the landlord both the right of possession during the lease term and the right to immediately recover all rents due under the lease. Because a landlord has no duty to mitigate its damages, most acceleration clauses (even those that discount for net present value) allow a landlord the potential to recover more than what it might receive, but for the breach. Thus, the decision in Van Duzer may signify the beginning of a trend toward unenforceability of these acceleration clauses.